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论老子

道,领导也。领导必需要不断呼唤,教导下属以及以身作则。下属的过和错皆因领导懒惰。

 
 
 

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Chapter 20: Capacity utilization  

2012-06-24 11:56:01|  分类: Buffer Mentality |  标签: |举报 |字号 订阅

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On May 23, 2008, John asked me, “Eric, Utilization factor is a highly debated subject. I don’t quite get what is the generally accepted way of defining the utilization factor. Can you share with me how do you define utilization factor? And how do you relate the production efficiency with the utilization factor?”

“Yes, I agreed with you. The ideal factory utilization factor is assumed to be equal to 100% to some folks. If it is not close to the ideal 100% the management has a tough time explaining to its board of directors. In the directors’ mind, they asked, ‘Why are you wasting my money and not making the equipment work non-stop?’

I fully empathize with the management team. To me it is easier to measure the production efficiency and report it vis-à-vis a 100% mark. The utilization factor is best left to be decided by the management on determining the optimum level of running its own operations without the board of director questioning why it is not equal to 100%.”

“I am a little confused with these two concepts. Can you bring me through one-at-a-time?” asked John.

I replied, “Okay, I try to share with you my idea how I would determine the utilization factor. I will discuss the production efficiency later.

First there are 365 days in a year. This is the universal calendar time.

Second, you have 52 weeks in a year and seven days a week. Perhaps, every Saturday and Sunday, your factory shuts down and you will lose two days a week.

Third, within a year you deduct the number of public holidays (say 9 days in a year) which the factory must shut down. Otherwise, you are going the labor laws.

Basically, if you were to use the denominator as 365 days a year, the net number of working days in a year is perhaps 252 days. That is about 69%. For almost one-third of the year, the factory is not running.

Fourth, if you were to run the factory for two 8-hour shifts only. That is, 16 hours per day. You will lose another 1/3 of the remaining 252 days in term of operating hours. That is equivalent to 168 work days of 24 hours each. Divide 168 days equivalent by 365 days in a year, the utilization factor is only 46%.”

John lamented, “That is pretty bad. The utilization factor is slightly less than 50%.”

 

Figure 20-1:    Determination of the utilization factor of a factory or a piece of equipment

Chapter 20: Capacity utilization - 浪里行舟 - 论老子
 

I defended my logic to the computation of the utilization factor, “No. the utilization factor may not necessary be that low. Let me use three examples to illustrate the different sensitivity to the utilization factor.”

 

Illustration #1: An oil refinery plant

 

I explained, “To build an oil refinery plant in today’s investment term, it cost several billions of dollars. The refinery therefore, must be running 365 days a year non-stop. However, the refinery needs to be downed for several days in a year for major maintenance, upgrading and repair. The project manager usually had to plan for the plant shutdown very meticulously in order to get the plant up and running as soon as possible.

A day lost in maintenance means a day’s lost in production output. The management of an oil refinery finds it realistic to measure the utilization factor as the ratio of the net uptime (365 days minus downtime) divided by 365 days and multiplied by 100%. Usually the utilization factor is quite high and closer to a utilization factor of 90% to 95%.

When the oil refinery management reports the utilization factor he feels good about a high, 90% rate. The board of directors would not question the management on the utilization factor. In this example, reporting a high utilization factor is not an issue.”

“I fully agreed with you,” said John.

 

Illustration #2: A steel rebar fabrication factory

 

I continued to explained, “Eastern Steel Services, a subsidiary of NatSteel Ltd that specialized in cut-and-bend of rebars[1] of varying diameters to specific lengths and bend them to the required shapes. The combination of finished products is close to several thousands. In other words, everyday the factory is churning a large variety of finished products.

A main contractor working in a building and civil construction development site has very limited space to perform cut-and-bend of rebars. It could hardly have any space to store the cut-and-bent rebars. Therefore, it demands the factory to produce exactly what it wants for today’s consumption. These rebars must be delivered on time to the construction site by the set window of two hours where the crane hoist them up to the desire location or onto the current storey where the building activities is currently being carried out.

An order placed yesterday must be delivered today. That is the main contractor’s utmost concern. However, Eastern Steel Services had several hundreds of customers on its book. On the average there are about 50 customers who placed an order everyday. Of course, some days, the number of orders would be less than 30 orders and sometimes, the number of orders could be more than 60 orders.

That means, Eastern Steel Service factory capacity must be able to swing upwards to more than 100% its normal demand. Here are the computations for its utilization factor.

Among the 168 work days, a 5-hour OT everyday shall contribute to another 31% (5 hours overtime/16 hours normal working hours available in 2 shifts) or 1260 worked hours a year.

Assume during Saturday and Sunday the factory runs for 21 hours overtime and multiplied that by 104 days equals to 2,184 hours in a year.

The total number of overtime hours available is 3,444 hours (1260 hours plus 2184 hours).

Divides 3,444 hours by 8760 total available calendar hours in a year (365 days and 24 hours a day), the added capacity due to over time alone is 39%.

The management at Eastern Steel Services can justify the factory designed capacity based on a utilization factor of 46%. It shall then assume that 39% of the factory utilization is reserved for over time. This is absolutely necessary because the factory must produced on demand and must assure on-time delivery services 100% of the time at short notice placed just one day in advance.

 

Figure 20-2: Over time factor

Chapter 20: Capacity utilization - 浪里行舟 - 论老子
 

 Of course, the reported actual utilization factor can dance from as low as 46% right up to 85% (46% + 39%). It all depends on the pattern of orders coming in. Certainly the factory has no control over the volume of orders coming in. It depends on the weather and the speed of construction works at all the sites.

The board of directors did not question the utilization factor of this factory simply because the factory loading is total not within the control of the factory and the factory cannot apply smoothening of the production order over several days to achieve a level production pattern.

The winning strategy for this company is to keep a high level of flexible production capacity to produce all its customers’ orders within a order lead time of just one day.”

John exclaimed, “I couldn’t imagine you designed a factory with so much up-side flexibility in the production capacity. And you did it simply because your customers demand one-day order to delivery lead time. That is truly a world-class performance.

I doubt Toyota Motor Corporation could build a car in one day based on what you ordered yesterday. Moreover, a single order you received could be a basket of 30 different products. ”

I smiled and said, “Thank you, John. You think too highly of me.”    

 

Illustration #3: Investment decisions made in Hewlett-Packard

 

I continued to explain, “Mark Hurd, the new CEO of Hewlett-Packard, reiterated the importance of growth and scale for HP in one of his coffee talks with his employees in Tokyo, Japan. ‘Good companies grow,’ he explained, ‘Great companies grow at the same time they reduce their costs. Good companies can get costs down.

In fact, there are a number of companies that come to work every day and all they think about is getting costs down. They don’t worry about growing revenue. And there are other companies that are very good at growing revenues. We’re almost one of those types of companies. But great companies grow revenue and get costs down at the same time. We’re trying to get there and do both.’

What he said was if you read between the lines, Hewlett-Packard is not doing enough to drive its cost down. They did not drive cost down fast enough simply because they do not know the actual number of what its production capacity is. This is because they do not compute the utilization factor of its factory.

Following is a true story of Hewlett-Packard operations.

In the inkjet printer market the competition is so fierce that prices of printers, which are usually sold bundled with personal computers have been hammered down to sub-US$100. As the marketing people say, “It becomes almost impossible to make money out of selling printers.”

The profitability game plan is to get as many printers out there in the market as possible. Forego the profits from the sale of the printers[2]; money is to be made when the consumers come back to buy the ink bags or pen cartridges later. For that matter, trade cartridges that are pre-installed into a new printer are filled with 5 milliliters of ink only; while the regular cartridges are filled to its full capacity of 38 milliliters.

Hewlett-Packard designed a new ink cartridge to replace its old cartridges that in the first place were not designed with the above marketing strategy in mind. Calculations showed that they have to build almost 30 similar set of Lava[3] production lines to meet the projected sales volume. This message was announced in one of the meet-the-employee world tour among the four ink cartridge making plants in the US, Puerto Rico, Ireland and Singapore.

During the questions and answers session, questions were raised about whether the sales volume could materialize to justify 30 sets of production lines or not. Of course, the number one worry among the employees is whether the new cartridge design is going to be a success or not. Their jobs are at stake. The company’s future profitability is dependent on its success in protecting its leadership market share and thus, guaranteeing them jobs.

Nobody questioned if that was an over investment in too many production lines and thus, HP is building excess production capacity. It costs about US$10 million[4] per set of production line. That’s a total investment of US$300 million, which is a large sum of money, poured just into the investment of production lines alone.

What about investments in the factory space, facilities, and people to operate it? Certainly it would be many times more. The employees were happy because there will be 30 new production lines to keep them occupied to make their job to be more exciting and possibly there will be more workers added.

Investments of such magnitude usually go to the board of directors for approval. I wonder if the board of directors of Hewlett-Packard, who represents the shareholders, ever asked if the same volume of business can be done with less number of production lines. Say, 30 percent less?

Was the management asked to re-look into the possibility of buying 30 percent less production lines?

No. Not likely. Otherwise, the management would not have made the announcement of investing in 30 new production lines.

Of course, investing in one-third less lines means a direct savings of not less than US$100 million. On top of that there will be a lot more savings in other investments such as: one-third smaller factory space, lower facilities and direct manpower cost, variable overheads and utility bills. This could accumulate into hundreds of millions of dollars in annual savings.

Was the proposed 30 production lines a magic number or based on solid facts? 

Let’s look into one of Hewlett-Packard’s most successful mass production lines. The ‘Tiger’ assembly line that produces the Hobbes pen cartridges was built and commissioned with an initial output volume of 100 [5](number has been converted to a baseline figure) pens per day. Management consistently pushed the daily output to 120, 140, 170, 190 and finally to its best record of 200 pens per day over a period of five years. By this time, they have added the thirteenth Tiger line.

Every year, there was a grand celebration for breaking the previous year’s daily output record. Great effort isn’t it, you might think. Everybody loves to see this consistent positive uptrend. It simply is a lovely picture of continual improvement. That’s what you would expect from the kind of management leadership who had the drive, wouldn’t you?

But if you were to look back more carefully, the productivity level of the Tiger line for its first year was less than 50 percent. Even at its best record of 200 pens per day, its productivity level might not be approaching anything near 100 percent.

Of course, after having invested so much money in building the Tiger lines, you would want it to be operating at 100 percent level in the utilization factor right from day one, wouldn’t you?

Though this is not possible, and we all know it is impractical, given that the people need time to understand the machine, technology and methodology to operate the machine and you allow a period of time to ascend the learning curve. But isn’t five years a little too long for that?

Compared to many more efficiently run companies, taking five years to reach close to its optimum production output level is simply far too long. Retrospectively, a continuous improvement in increasing the daily output records over a period of five years is certainly not a crediFigure performance but rather poor management instead.

To explain for this phenomenon, the best explanation is the equipment utilization factor started from a very low base and over 5 years, it gradually doubled.

In this case, what can the board of directors of Hewlett-Packard do?

It cannot reject the proposal submitted by its management. There is a real need to install these production lines. Otherwise, they can kiss the printer market good-bye. But what it can certainly do is, in addition to accepting the proposal to build 30 production lines to meet the projected market volume, it can ask for a utilization factor and a productivity target.

There is nothing wrong in asking the management to bring in and install the production lines gradually one after another. In reality the speed of installing the production lines is more or less in-line with the production capacity required to meet the projected sales volume. The key difference here is that the management is required to manage each production line well and therefore, quickly catch up with close to the 100 percent productivity level as soon as possible.

To arrive at the decision that 30 new lines were needed the inkjet management had single-handedly used the cost of production per cartridge to justify for the investment. Of course with technological improvements in both the design of the product and production technology, the cost per unit of pen cartridge would have gone down over the years. But this could still be much lowered if a productivity target is set.

In my humble opinion, they should have asked for a set of utilization factor and include a productivity indicator based on the operating speed of the new production line. And I believe Hewlett-Packard’s board of directors was not wise enough to have insisted these two factors.

Every finance manager knows that machine productivity is something directly linked to how well the investment money is being put to use. The higher the utilization of the machine and the higher its productivity and it certainly leads to higher returns on investments. That is a simple logic, isn’t it?

On the other hand, from an operations perspective, if you have invested say, US$10 million to purchase a production line, of course you’d want that first production line to be running all the time at 100 percent operating speed before you decide to purchase a second line.

In this example, I am sure it did not need to take all 30 lines to produce the projected ink cartridge volume. If the board of directors of Hewlett-Packard had dictated to its management that it must measure the equipment’s utilization and productivity factors in order to gauge the final number of production lines to be purchased, they will definitely not end up purchasing 30 lines. They could have stopped their purchases at perhaps, 20 production lines as a direct result of its management putting in the extra effort to increase the utilization and productivity by 30 percent above their initial proposed calculations. What will that lead to?

On top of the savings of 100 million US dollars in cost of purchasing the 10 additional production lines, hundreds of million of dollars more in annual savings can be realized from a whole one-third less factory space, manpower, overheads, utility bills etc.

The gross margin could easily be increased by at least 30 percent. Cost, which is one of the key evaluating factors of how successful the investment was, would have gone down tremendously.

Since the board of directors of Hewlett-Packard had not asked the management to measure the productivity of the new production lines, its management would have stuck to their initial calculations and went ahead to purchase all 30 production lines with one blanket purchase order. Whether the management later managed to increase the productivity by 30 percent or not, this investment would have been sunk in. And together down the drain a whole lot of other costs and expenses in the added factory space, manpower and utilities etc.

Its management did not feel it was wrong not to have asked for the utilization factor and subsequently set a productivity target for these new production lines. After all, all these capital investment in equipment, interest payable, cost of materials, labor expenses, cost of acquiring new technology, variable overheads and fixed overheads had already been approved by its board of directors. They were merely executing a planned investment.

Moreover, it is very unlikely its management would voluntarily want to set a productivity goal for its investment plan. And for sure the management did not. Two years down the road the daily output volume was used as the productivity indicator and nobody ever asked which level of utilization factor or targeted productivity that the daily output should achieve. A quick estimate showed that it was at best 70%.

In this case study, actually, there is no need to put in any effort to hide any information. The directors of Hewlett-Packard simply did not even ask for the information that the need to keep to a high level of utilization factor nor the productivity of the new lines must be up quickly to near 100%.

Summing up, the buffer mentality among management is not obvious at all in this case. The question about the utilization factor of the factory is simply left unanswered. They preferred to choose to use the productivity efficiency indicator to measure his factory returns. Please refer to chapter 16, ‘Setting productivity indicator’.”

John was totally astonished. He said, “Eric, this is precisely the problem in Honeywell. None of us knows what the utilization factor is for any one of its 250 sites. Nobody talks about it. Nobody cares about it.”



[1] Rebars mean steel reinforcement bars usually use in the construction industry.

[2] In order to lower the selling price of the printers, one way is to reduce the amount of ink in the cartridge. The consumers generally do not question how many pages of document it can print.

[3] The final number of Lava production lines built was about 30.

[4] The cost of each Lava production line is around this figure. Actual cost of installation varies with the slight different configurations for each production line.

[5] This figure is converted to a base 100 for ease of comparison. Actual number is a trade secret.

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